Recycling resources

The Community Reinvestment Fund links economic development financing more closely with capital markets and gives community-based lenders a funding option other than uncertain sources of government money.

Reduce, recycle, reuse. This familiar slogan appears
on everything from waste baskets to milk jugs and reminds us to
be conscious about the wise use of scarce resources. The Community
Reinvestment Fund (CRF), an innovative Minneapolis-based organization,
has a new twist on that philosophy for the community development
lending field: increase the number of community development loans,
sell the loans on the secondary market and recycle the proceeds,
and reuse that money for more loans. CRF, which promotes this lending
cycle as a way to stretch community development resources, is a
leader in showing how a secondary market for community development
loans can help build stronger and healthier local economies.

CRF works to develop a well-functioning secondary market for community
development loans in three ways. First, it promotes access to a
steady source of funds for borrowers by purchasing loans from community-based
lenders (such as local revolving loan funds, city governments, and
housing and economic development authorities) that use the sale
proceeds to fund more loans. Second, its loan-servicing organization,
Community Reinvestment Services, works to ensure that borrowers
repay their loans as agreed. Finally, it issues loan-backed securities
with competitive rates and a low risk profile, factors that are
attractive to investors and promote the long-term viability of the
market.

This article discusses the forces behind the creation of CRF,
its three-part strategy to develop and expand the secondary market
for community development loans and its plans for the future. CRF
is a success story that provides interesting insights and ideas
for readers seeking new opportunities to improve their communities.

Getting started

Increasing demand for community development funds and important
tax law changes provided the impetus for creating CRF in the late
1980s. The organization's founders, Frank Altman and Warren Hanson,
were seeking new sources of funding for economic development projects
when they developed the idea for a new secondary market for these
loans. Both men were working in government on economic development
issues and recognized the importance of changes in the Tax Reform
Act of 1986. The new tax code put limits on the issuance of industrial
development bonds, which had provided a substantial source of economic
development financing. There was no obvious funding source to replace
the bonds, and other government grants and subsidies were beginning
to dry up.

CRF started operations using foundation grants and a $200,000
matching grant from the Minnesota legislature (the $200,000 is the
only government money CRF has ever received). Altman, who has served
as CRF president since its inception, and the foundation supporters
strongly believed that CRF should be a new model for financing community
development, that it should not be a government agency and that
it should be market-driven. The goal, according to Altman, was to
"demonstrate, create and operate a secondary market for economic
and community development loans."

Promoting increased access to loans

CRF was designed to address a fundamental problem most community-based
lenders face: demand for loans often exceeds the available supply
of funds. After a community-based lender has loaned out its initial
pot of money, new loans can only be made from loan repayments. These
repayments are often not adequate to replenish the loan fund to
meet new borrowers' credit needs. Excess demand for loans is generally
a "good" problem to have, since it indicates an active and developing
community and because lenders can choose the strongest credits.
However, if the supply of funds is too scarce, qualified borrowers
who could be creating housing or jobs in a community do not receive
funding. Community-based lenders often find it difficult to raise
additional capital to make loans, especially in times of increasingly
limited government grant funds.

By purchasing loans from these organizations, CRF provides community-based
lenders with new funds they can then lend to other borrowers. The
loan sellers must agree to relend the proceeds of the sale for economic
and community development projects. They cannot use the proceeds
to fund other local needs, such as street repair, which can be tempting
in budget shortfall times.

Carol Anderson is the executive director of Community Development
of Morrison County, Inc., a nonprofit economic development corporation
with a revolving loan fund that serves manufacturing businesses
in rural, central Minnesota. Her reason for involvement with CRF
is fairly typical, especially among the small community loan funds
that have sold loans to the organization. "I sell loans when I don't
have any more money to lend," Anderson says. "If there are no good
prospects waiting for loans, we try to build up our fund through
loan repayments rather than selling our existing loans. But sometimes
there is a company that needs money right away, and selling loans
to CRF gives us access to funds to make the project happen."

CRF purchases loans from a variety of organizations, but it is
not intended to be a source of liquidity for banks. CRF has purchased
participation loans from banks, but only from bank community development
corporations (CDC) where the CDCs agree to reinvest the money in
economic and community development loans or investments. However,
many banks are involved in some way in loans sold to CRF, even if
they are not the sellers. For example, Community Development of
Morrison County requires private lender participation on all of
its loans. In many cases, the bank loan would not have been made
unless money from the revolving loan fund was also available to
the business. Consequently, the more loans made by a community-based
lender, the more likely local banks are to participate in community
development projects.

Quality loan servicing

In its years of operation, CRF has determined that standardized
loan documentation and specialized loan monitoring and servicing
are vital to creating and maintaining a viable secondary market.
As directors of community loan funds know, the challenge of lending
in the economic development and affordable housing markets does
not end when a loan is made. Ensuring that loans are being paid
as agreed, known as loan servicing, can be a significant challenge.
Loans may be structured with unconventional terms to meet the needs
of the borrower, a situation that can make tracking payments and
maintaining accurate loan files more difficult than a conventional
loan. The staff of a small community revolving loan fund may lack
the time and expertise to service loans properly or to work out
new terms with a borrower who is having trouble making payments.

In response to these concerns, CRF is developing Community Reinvestment
Services (CRS) as a separate division to provide specialized monitoring
and servicing for community development loans. According to Dennis
Sonnek, CRF vice president and chief financial officer, CRF recognized
a need for an entity to service as well as purchase loans. Previously,
CRS only serviced loans sold to CRF but has expanded to offer loan
servicing to community-based lenders on a contract basis. CRS currently
services about 1,500 loans. Community-based lenders can contract
with CRS to service their loans even if they are not interested
in selling the loans to CRF.

CRF and CRS provide training and information to loan fund managers
to teach them about proper loan documentation and servicing. Some
organizations have had difficulty selling their loans because of
inadequate documentation, which also makes proper loan servicing
much more difficult. To address these problems, CRF developed a
manual with detailed information about proper documentation needed
to improve servicing and obtain the highest sale price for a loan.
Even if an organization chooses not to have CRS service its loans,
the loan fund managers will have learned valuable skills.

The Family Housing Fund of Minneapolis and St. Paul (FHF) has
a contract with CRS to service its loan portfolio. This private,
nonprofit group makes affordable housing loans, frequently with
30-year deferred terms. Selling the loans on the secondary market
is not feasible because they don't generate revenue streams, but
they still require servicing.

According to Anita Pierce, office manager at FHF, CRS provides
an important service. "CRS monitors insurance requirements and reviews
the financial statements for the projects we fund," she says. "We
have some loans with 15-year balloon payments, which means we need
to monitor the financial status of those projects to protect our
investment. We also have some loans made several years ago that
are amortizing (meaning they require regular payments by the borrower,
like a home mortgage), so CRS ensures that payments are being received
on those loans."

FHF receives a monthly report from CRS on the activities in its
portfolio. Pierce is the only staff member available to monitor
the loans, so having CRS do the loan servicing saves her substantial
time.

CRS also works with the local lenders to handle more difficult
servicing situations, such as defaults, write-offs and recoveries,
even if they have sold the loans. CRS believes it is important to
keep the local sellers involved in such decisions because they have
a direct effect on economic conditions in their communities.

CRF purchased the loan made to Northern
Cap Sewing, Little Falls, Minn. The loan allowed the manufacturer
to expand operations from Minneapolis and create 60 jobs in
this central Minnesota community.

Issuing attractive loan-backed securities

The sale of securities to investors completes the cycle of reinvestment
that begins when CRF purchases the loans from the local sellers.
To accommodate the needs of smaller local organizations, CRF purchases
their loans and holds them until they have enough to package together
for a security sale. Altman noted that although larger loans may
require less work to package, CRF has a special commitment to work
with small organizations.

According to Altman, CRF believes that the investors in its securities
must get a competitive return. CRF purchases below-market rate loans
at a discount and prices them to yield a market return. As of July
1997, CRF has purchased 753 loans worth $37.6 million, with $34.1
million in proceeds returned to the sellers. This means that, on
average, sellers get about 91 percent of the value of their loans,
a figure not surprising since many of these organizations offer
loans at below-market rates. This discount pricing is necessary
because CRF believes it will not be successful if it is treated
as a charity or if investors are asked to take a below-market return.

CRF securities are attractive to investors because of their low
risk profiles. CRF has successfully solicited foundations for money
to fund a credit reserve. This reserve allows CRF to overcollateralize
its bonds and maintain loan cash flows of at least 120 percent of
bond debt service. In less complex terms, the extra cash flow provided
by the credit reserve gives investors a cushion to ensure they receive
full payment even if some loans are not paid as agreed. The reserve
also allows CRF to provide the sellers with the highest possible
price for their loans while still maintaining attractive rates and
a low risk profile for the securities.

Foundations are willing to fund the credit reserve because it
enables them to leverage their resources. Philanthropic organizations
that have financed the credit reserve include the Northwest Area
Foundation, US West Foundation and McKnight Foundation. Program-related
investments have also been provided by the Metropolitan Life Foundation,
Ford Foundation and MacArthur Foundation.

Maintaining an active market for its securities is an integral
component of CRF's success as a secondary market. Loan servicing
provided by CRS minimizes loan defaults, which helps to maintain
the attractiveness of the securities. CRF uses the proceeds from
the securities sales to purchase more loans from local organizations,
which provides a capital infusion in communities and renews the
reinvestment cycle.

Looking to the future

CRF has substantially increased its loan purchases and its presence
in the community development lending field since 1988, and it plans
to continue growing. It has purchased loans in 10 states and the
District of Columbia and has attracted investors from across the
country. Although there are other private affordable housing secondary
markets, the secondary market for economic development loans is
very limited. CRF is concentrating on states west of the Mississippi
River, but its eventual goal is to become a national organization.

Targeting innovation

As resources for community development decline, revolving loan
funds will need to look for innovative ways to continue making investments
that create jobs and housing in their communities. Altman estimates
that $4 billion to $5 billion dollars is currently tied up in revolving
loan funds. While not all of these loans are salable, selling only
a portion of these loans on the secondary market could free up a
substantial amount of money. Organizations like CRF are likely to
continue to grow as community-based lenders recognize the valuable
opportunities provided by secondary markets to recycle and reuse
scarce resources for more community development loans.